Trimble Stock and the Conglomerate Discount
Dictionary.com probably has the best definition of a conglomerate. It’s a corporation consisting of a number of subsidiary companies or divisions in a variety of unrelated industries, usually as a result of mergers and acquisitions (M&A). Some popular conglomerates in our dividend growth portfolio include 3M (MMM) and Johnson & Johnson (JNJ), though the latter may be planning to split up their business. Then there’s VF Corporation (VFC), another dividend champion we’re holding. VFC is a portfolio of clothing businesses resulting from M&A activities, but since they’re all in the same industry, it’s not considered a conglomerate according to our definition. Here’s why this matters.
The Conglomerate Discount
The Corporate Finance Institute published a concise easy-to-understand paper which talks about the conglomerate discount. It’s an economic theory that proposes conglomerates trade at a discount, largely because the market penalizes companies for a perceived lack of focus. From the CFI paper:
Perhaps the simplest way to understand a conglomerate discount is to understand how it is calculated. It is a discounted valuation of the stocks associated with all of the divisions/subsidiary companies within a conglomerate. Valuation is determined by adding together the intrinsic value of all the smaller companies within a conglomerate, then subtracting the market capitalization for the conglomerate. It typically results in a 10%-15% discount in valuation for the conglomerate.The Corporate Finance Institute
As risk-averse investors, we’ve always ascribed a mental premium to conglomerates because of the diversification effect they provide. Management consultancy Marakon talks about how this reduction in volatility gives companies “the ability to deploy far more capital and take more risk in one of its businesses than could a pure play.” They also cite potential synergies as a benefit for conglomerates along with portfolio management which is “the potential for management to make both profitable acquisitions and divestments.” Their findings revealed many diversified companies have developed competencies in doing profitable deals, a benefit that could also be realized by firms that only dabble in a single industry (VFC comes to mind here).
Is Trimble a Conglomerate?
In last year’s article, Trimble Stock – Farming, Construction, and Supply Chains, we described Trimble as an IoT firm that crosses over multiple industries including construction, transportation, and agriculture. By definition it’s a conglomerate, and they also have the M&A activity to prove it. Trimble’s various industry focuses map to the formal reporting segments seen below along with revenue/profit contributions and year-over-year growth in 2021.
|Segment||Most substantial product portfolio||2021 YoY Growth||Margin||% of Total|
|Transportation||The truckload freight market||-1%||6.8%||17%|
|Resources and Utilities||The agriculture market||22%||34.2%||21%|
|Building and Infrastructure||building construction and civil engineering and construction.||16%||28.9%||39%|
|Geospatial||Surveying and geospatial and geographic information systems (GIS)||27%||29.4%||23%|
In its 43-year existence, Trimble has bought over 100 companies and sold more than a dozen. The firm divested 3 businesses in 2021, 4 businesses in 2020, and 5 businesses this year (so far) which are as follows:
- Beena Vision Systems – Acquired in 2017. Provides automatic wayside inspection systems for the railroad industry using sophisticated machine vision and non-contact measurement technologies.
- Loadrite – Acquired in 2013. Provides weighing system for wheel loaders, excavators, conveyors, and waste collection vehicles.
- Spectra Precision Tools – Supplies precision laser tools and solutions to the construction and surveying markets to enhance productivity.
- SECO – Acquired in 2008 – Manufacturer of accessories for the geomatics, surveying, mapping, and construction industries.
- Protempis – Builds time and frequency products catering to industries that rely on precise timing for synchronization and operational efficiency.
The sale of these businesses minimally impacted Trimble’s revenues – about $145 million in revenues or 3.8% of the $3.8 billion in 2022 guidance – which seems like a problem. Why acquire businesses that don’t meaningfully impact your top or bottom line? That sort of behavior might lead investors to punish you for a lack of focus – the old conglomerate discount. Fortunately, Trimble’s new CEO (joined early 2020) is championing a strategy called “Connect & Scale 2025” which the company says, “will accelerate our move toward subscription business models both in software and hardware, we will connect our solutions into bundled offerings, and we will begin to enable a data strategy that we believe we are uniquely positioned to fulfill.” The growth of annual recurring revenues (ARR) becomes a key metric to watch going forward as the company moves towards a recurring revenue subscription model.
The industry mix reflected in Trimble’s product portfolio provides stability in times of economic turmoil as evident by how shares have performed in the current bear market. There’s a concept in finance referred to as “beta” that measures the extent to which a stock price will move relative to its index. They make you calculate this stuff in portfolio management classes, and it’s about as interesting as a game of cricket.
We like to keep it simple. The Nasdaq has a year-to-date loss of 28% while Trimble has lost 33% over the same time frame. Since Trimble trades on the Nasdaq, we need to remove the index performance component which means Trimble lost 5% year-to-date. That stability is the diversification effect at work. Key takeaway: when measuring the performance of any stock, always consider an appropriate benchmark.
Trimble’s diversified business lines also mute the potential returns of any given segment. It’s to be expected that larger companies don’t grow so fast, and that’s reflected in a simple valuation ratio of 4 which is quite low when compared to a selection of stocks in our tech stock catalog. That said, Trimble expects revenue growth for 2022 to be nearly 21% based on guidance of $3.8 to $3.88 billion. Not bad for a conglomerate.
UPDATE 11/02/2022: Yahoo Finance had incorrect revenue data for Trimble – they had 2020 revenues listed as 2021 – which means their revenue growth (based on Q3-2022 guidance) will be flat.
We always emphasize the importance of pure plays. So, is a collection of pure-play companies in diverse industries equally as valuable as owning all separately? Yes, especially if that collection is trading at a discount. Given the dearth of quality IoT stocks, we moved into a Trimble position as way to play multiple growth themes. We particularly like the geospatial and agriculture exposure which made up nearly half of Trimble’s 2021 revenues. As the current bear market decimates growth stocks, Trimble is showing some resilience because their various business segments are providing a diversification effect. Should we decide to add some shares of Trimble, Nanalyze Premium annual subscribers will be the first to know.
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